US Small and Medium Banks Face Wave of Failures... "Recalling the 1980 Series of Bankruptcies" (Comprehensive)

The banking crisis triggered by the bankruptcy of Silicon Valley Bank (SVB) in the United States has passed a month and a half, but fears of the crisis spreading to small and medium-sized regional banks continue. There are even warnings that a banking insolvency crisis comparable in scale to the chain collapse of U.S. savings and loan associations that began in 1989 could engulf the global financial market.

On the 23rd (local time), The Wall Street Journal (WSJ) reported that the current financial market situation resembles the troubled savings and loan crisis that began in the late 1980s, which caused hundreds of bank failures over several years and severely damaged the U.S. economy. Just as hundreds of savings and loan associations collapsed or required bailouts over several years amid rapid interest rate hikes more than 40 years ago, it is expected that the crisis among small and medium-sized regional banks may continue at a slow pace.

WSJ stated that although liquidity has stabilized as banks with strong government support and ample funding capacity have taken the lead, the risk factors faced by small and medium-sized regional banks have not been resolved.

The biggest risk factor facing small and medium-sized regional banks is the massive withdrawal of deposits. As banking sector risks spread, thousands of billions of dollars in deposits from small and medium-sized banks are moving to money market funds (MMFs), which have relatively low credit risk, high liquidity, and profitability. WSJ pointed out that as money moves from small and medium-sized banks to MMFs, a slow and steady erosion of deposits will continue.

Comparing the asset-liability structures of 25 large and small banks clearly reveals this risk. For large banks, average deposits have gradually decreased from 5.56% year-over-year on March 1 (shortly after the SVB bankruptcy) to 4.2% on March 29.

However, for small and medium-sized banks, deposits sharply declined from 15.15% to 10.18%. This reflects the fact that the SVB bankruptcy mainly affected small and medium-sized banks. Such deposit outflows lead to increased funding costs for small and medium-sized banks. In a steep interest rate hike phase, this raises the risk of credit tightening and is why warnings persist about the possibility of a second or third SVB-like crisis occurring.

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International credit rating agency Moody's reflected these risks by downgrading the credit ratings of 11 small and medium-sized regional banks in the U.S., including Western Alliance Bancorp, US Bancorp, Zions Bancorporation, and Bank of Hawaii, on the 21st. Western Alliance Bancorp, one of the hardest-hit banks in the SVB crisis, saw its credit rating lowered by two notches. As of the end of 2022, more than half of this bank's deposits were uninsured, and in the first quarter of this year alone, 11% of deposits were withdrawn.

The recently downgraded US Bancorp was criticized for its low capital ratio and large unrealized (book) losses. Earlier, during the COVID-19 pandemic, U.S. banks invested the flood of deposits into safe assets such as U.S. Treasury bonds. However, with rising interest rates causing Treasury bond prices to fall, unrealized losses have significantly increased. There are concerns that some banks might follow SVB's path by selling bonds at a loss to raise funds for deposit withdrawals. Zions Bancorporation also faces significant unrealized losses in its securities portfolio and capital deterioration.

Moody's analyzed, "Banks are facing increased burdens in managing assets and liabilities and are under pressure on profitability," adding, "The recent banking crisis has raised questions about whether banks need to reassess the stability of deposits and their operational methods."

The reduction in lending caused by deposit withdrawals from small and medium-sized banks tightens financial conditions further and increases economic uncertainty. The largest U.S. investment bank, Goldman Sachs, estimates that every 2% decrease in bank lending results in a 10% decline in bank profitability. In fact, a recent survey conducted last month among small businesses affiliated with the National Federation of Independent Business (NFIB) reported that more U.S. small businesses are experiencing difficulties obtaining loans due to credit tightening following the SVB bankruptcy. The proportion of small businesses responding that financing was more difficult compared to the previous month (before the SVB crisis) was 9%, the highest since December 2012.

Goldman Sachs also forecasted that this credit tightening could reduce economic growth by 0.3 to 0.5 percentage points this year as it restricts corporate activities. Credit tightening also increases the long-term risk of corporate bankruptcies. Robert Kaplan, former president of the Federal Reserve Bank of Dallas, stated, "Small and medium-sized banks across the U.S. are simultaneously freezing or reducing their loan-to-deposit ratios at current levels," and predicted, "Loan extensions to companies may not be made by the end of the year, or loan terms may be renegotiated."

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